The artificial intelligence (AI) craze appears to be simmering down. For about a year and a half, technology equities valuations have ballooned as both institutional and retail investors have poured lump sums of capital into the burgeoning space of generative AI. With valuations as high as they have become, however, many investors are beginning to ask follow-up questions. When will these large AI investments pay off?
Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL) delivered a mixed second-quarter earnings report for fiscal year. In particular, ad revenue for YouTube came in lower than expected at $8.7 billion. Alphabet reported quarterly capital expenditures rose to $13.2 billion, exceeding Wall Street analysts’ estimates of $12.2 billion. Because investors are now concerned about the return-on-investment (ROI) on that capex, Alphabet shares plummeted. Other AI-related stocks took similar hits when signs of a slowing U.S. economy in the macroeconomic data spooked equities investors broadly.
Markets have become relatively stable since the recent sell-off, but there are still chip stocks to avoid. Below are three of them.
Intel (INTC)
Intel has been a recurring semiconductor stock on my “sell” lists this year, and recent movements in the semiconductor firm’s price have confirmed my reservations. INTC shares have plummeted more than 60% since the start of 2024. There are a few things to unpack here.
The once crown jewel of America’s semiconductor industry has struggled for years now to innovate at the pace of contract chip manufacturing leaders, like Taiwan Semiconductor Manufacturing Company (NYSE:TSMC). Bottom line is, Intel’s Foundry business, which manages the fabrication of its chips, is a mess. The manufacturing business, which Intel siloed off as a separate entity earlier in 2024 as a part of a thorough restructuring plan, lost $7 billion last year.
Now, recent investments into developing AI chips contributed to a significant hit to Intel’s earnings per share figure in the second quarter of fiscal year 2024. In other words, the recent capital expenditures related to novel AI chips is starting to really cost Intel money, and there does not seem to be a silver lining in sight. In fact, the drop in profitability has prompted Intel to re-envision its entire operating model, starting with the layoff of 15,000 workers, a dividend elimination, and the reduction of future capex.
The chip giant also issued soft guidance for Q3, further aggravating investors’ worries. Despite its low valuation, Intel’s stock will continue to face downward pressure as operational inefficiencies and competitive risks take their toll on the company’s earnings.
Qualcomm (QCOM)
Qualcomm (NASDAQ:QCOM) is another semiconductor stock that I have fairly bearish on since the latter half of last year. A major lack of demand for new smartphones as well as a consumer technology glut that has been around since the pandemic years have both resulted in headwinds for Qualcomm’s. For more context, Qualcomm’s monetary lifeline is tied to the smartphone industry. Handsets running Google’s Android operating system tend to leverage Qualcomm’s Snapdragon system-on-a-chip (SoC) for processing and graphics power as well as the firm’s zippy wireless modems. In fiscal year 2023, which ended on September 30th, 2023, Qualcomm saw revenues decline 19% year-over-year to $35.8 billion — handset chip revenues in particular dropped 27% on a year-over-year basis.
To revitalize its chip business, Qualcomm has placed bets on its new Snapdragon X Elite AI chips that will power a range of Windows PCs. While these PC chips are not for gamers, they appear to be quite snappy for all kinds of productive tasks. The question now is, will consumers rush to buy new laptops because they have AI chips in them. While the labor market is struggling and recession fears are heightening, investors should definitely exercise caution moving forward.
QCOM has plummeted 27% since hitting its 52-week high of $227.09 in mid-July, and investors scrutinizing AI companies could lead to further selling pressure in August.
Applied Optoelectronics (AAOI)
The AI revolution has also sparked a major interest in data centers and the companies that help build them. Amazon (NASDAQ:AMZN), Google, and Microsoft (NASDAQ:MSFT) operate a plethora of data centers for their large cloud services platforms, but outside of these large businesses, there are the semiconductor and communications equipment companies that build the optical cables, transceivers, and transmitters that make these data centers function. Applied Optoelectronics or “AOI” (NASDAQ:AAOI) is one of these firms. AOI develops optical transceivers and laser components that help develop the necessary components that form the bedrock of a fiber optic network.
AOI’s customer set includes both data center operators and telecommunication services providers. While AOI is expecting the former to grow steadily, the segment is not growing as fast as it should, especially given the talk about the need for more data centers to develop large language models (LLMs). Telecom customers have also been a rough spot for companies in the space, as telecom companies are still digesting inventory bought towards the end of the pandemic years, stifling revenue growth potential for firms like AOI in the short and medium term.
AAOI shares have plummeted 60% since the start of the year, and without any large upward revisions to guidance, investors should not hope for a miracle turnaround.
On the date of publication, Tyrik Torres did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.